Starting a marijuana business is gaining a lot of popularity. The industry seems to be flourishing, and many people are making millions of dollars from it. If you’ve been considering starting a cannabis business, think about business valuation first.
With the expected surge from $7.7 billion to $31.4 billion between 2017 and 2021, valuation is essential. You might want to buy a cannabis business instead of starting from scratch. You might also want to sell off your business at some point.
Just like with any other business, there are underlying cannabis businesses valuation principles that apply. You need to know about the long-term value of your investment considering it’s a new industry. There’s a significant level of potential fluctuation and legal risk.
They are several factors that can make valuation challenging.
Five ways of measuring your investment in your cannabis business are
- Asset-based valuation
- Earnings-based valuation
- Historical earnings valuation
- Relative valuation
- Future maintainable earnings valuation
Read along to understand what each one entails.
This approach to valuation takes into account the assets of the company. It includes tangible assets like plants, equipment, and the staff. It also includes intangible elements like a loyal customer base, brand name, and relationship with the stakeholders.
The license to operate is also crucial in the cannabis industry. In areas like Washington where it’s difficult to obtain a permit, the value of a license counts towards valuation.
Asset-based valuation does not take into account the unique opportunities for potential growth. Some people prefer the approach because it acknowledges the risk of the industry. The method also recognizes that growth is not a guarantee.
Earning-based valuation doesn’t take into account the possibility of future earnings. In the approach, a base multiplier like five is used to multiply the current net value of the company. For example, a company with $100,000 in revenue would be worth $500,000.
One challenge with this approach is that there’s no set multiplier in place. In other established industries, valuation experts have agreed on a single multiplier.
Since the cannabis industry is still new, the sale of businesses is still a new concept. Disputes are bound to arise on the multiplier to use, especially between the buyer and seller
Historical Earnings Valuation
The approach takes into account a business’ gross income and its ability to repay debt. Other factors are the capitalization of cash flow and earnings which govern the current value. If the company struggles to bring in enough revenue, its value decreases.
Quick repayment of debt and maintenance of positive cash flow increases the value of the business. All of these factors are critical while using the historical earnings valuation approach.
The relative valuation determines how much other businesses in the industry would bring in if sold. It’s a comparative approach that compares the value of your assets to similar assets. From this, you’ll get an idea of the reasonable asking price.
Future Maintainable Earnings Valuation
The future profitability of your business determines its current value. You can use the future maintainable earnings valuation approach if you expect profits to remain stable. The procedure entails an evaluation of its sales, profits, expenses, and gross profits for the past three years.
The figures are essential in helping you predict the future. They also help you value the business at the current day.
Cannabis business valuation is currently a bit challenging. This is because the industry is still relatively new. Before you start the business, you need to know the approach to use in valuation.
Regardless of the industry, valuation principles remain the same. Understanding the underlying concepts of each valuation approach will help you choose the most appropriate.